PDVSA's Debt Restructuring: The Chapter 15 Option

posted by Mark Weidemaier

Mitu Gulati and Mark Weidemaier

This past week, Bob Rasmussen of USC Law gave a talk at Duke on “Puerto Rico and the Netherworld of Sovereign Debt Restructuring.” Luckily for us, he also took a detour to UNC to talk to our International Debt students about whether PDVSA might use Chapter 15 of the Bankruptcy Code to restructure its debts. Our foil for that discussion was a recent paper by Rich Cooper (Cleary Gottlieb) and Mark Walker (Millstein & Co.) proposing Chapter 15 as a possible solution to PDVSA’s woes. This is one of a number of extant restructuring proposals for Venezuela and PDVSA; Lee Buchheit (working with Mitu) has published several others (here, here, and here). The Cooper and Walker proposal is the only one to explore the Chapter 15 possibility in detail, and it thoughtfully makes the case for that restructuring option. In very condensed form, the proposal is for Venezuela to pass a new bankruptcy law governing PDVSA and other public sector entities, for PDVSA to restructure its debts using that process, and then for PDVSA to ask courts in the U.S. to recognize that bankruptcy under Chapter 15.

One way to frame an analysis of this proposal is to ask what Chapter 15 offers that other restructuring tools—like Exit Consents—do not. Cooper and Walker detail a number of advantages, but it seems to us that the key ones are a stay of litigation by creditors and the ability to bind dissenting creditors (including non-bond creditors). We suspect it would be fairly easy for PDVSA to obtain a temporary stay of creditor litigation, as courts have discretion to stay creditor enforcement actions while working out preliminary matters in a Chapter 15 case. But a relatively short stay, while valuable, probably isn’t worth enough to justify the effort of enacting a new bankruptcy law. For a longer stay, and to give effect to a plan of reorganization, PDVSA would have to satisfy the eligibility criteria for Chapter 15, and the Venezuelan bankruptcy law would have to earn “recognition.”

In our Chapter 15 session with Bob, several fundamental questions surfaced, only one of which is squarely addressed by the Cooper and Walker proposal. One question has to do with political feasibility. To pass muster under Chapter 15, Venezuela’s new bankruptcy law will have to be administered by a credibly independent institution in that country. PDVSA will also have to submit to a certain amount of oversight by bankruptcy courts in the U.S. and elsewhere. It isn’t clear to us that any Venezuelan government—and certainly not the present one—will accept these costs. Cooper and Walker allude to this, and they seem to envision a new government implementing the plan. At least in the near term, however, it seems a major barrier.

A second question, which they do discuss at length, concerns PDVSA’s eligibility for Chapter 15 relief. PDVSA can’t reorganize under Chapter 11, because an instrumentality of a foreign government is not a “debtor” eligible to use that Chapter. A relatively recent case from the Second Circuit (In re Barnet, 737 F.3d 238) implies that the definitions in Chapter 11 might control eligibility in Chapter 15 as well, but Cooper and Walker lay out the counter-arguments in some detail.

Viewed purely as a question of statutory interpretation, the eligibility question might be a toss-up. But we do wonder whether U.S. courts will be disinclined to accept PDVSA’s arguments. That’s true on eligibility, but especially on questions of recognition. It’s one thing for a US bankruptcy court to recognize a well-established foreign bankruptcy regime, even one that departs in some ways from U.S. practice. But a brand new bankruptcy regime, with no track record at all (much less a track record of independence), enacted to benefit an entity not eligible to reorganize using U.S. bankruptcy law? That’s a big ask. And what if the U.S. government opposes recognition, if only to protect U.S. bondholders from having restructuring terms imposed against their will? (Recall that PDVSA’s bonds give each bondholder the right to reject a proposed modification to payment terms.) We suspect a bankruptcy judge would take that opposition very seriously.

Recognizing these concerns, Cooper and Walker propose an alternative. This route is more complicated. The first step involves the use of Exit Consents (and Mitu loves Exit Consents!). PDVSA would secure the approval of a majority of bondholders to change the governing law of the bonds from New York law to English law. Then, PDVSA would seek to reorganize through a so-called “scheme of arrangement,” in which 75% of creditors can impose restructuring terms on dissenters. Finally, PDVSA could seek recognition of this proceeding in the U.S. But of course, the threshold question of eligibility remains. Moreover, the use of Exit Consents will trigger scrutiny, both under New York and English law. PDVSA would have to explain how it can permissibly use this technique to accomplish the very thing it promised not to do in the bonds: impair a holder’s right to receive payment and to bring suit to enforce that right.

We have gone on long enough. The short version of our critique is simply that the Walker and Cooper proposal leaves us wanting more. It’s a provocative proposal by two extremely experienced restructuring professionals. But we remain skeptical that Venezuela can use such maneuvers to effectively cramdown bondholders. And while the issues are somewhat different, we are left with similar questions about other creditors, like those pursuing alter ego claims against PDVSA based on expropriation by Venezuela.

Comments

I have two issues/questions regarding the Ch. 15 suggestion. The first being, would Venezuela ever actually pass a law that US Bankruptcy Courts would acknowledge? Secondly, would Venezuela ever consent to put its "prized jewel" (PDVSA) into bankruptcy? These seem like huge obstacles to me (echoed above), and I see more scenarios where they are answered the negative than affirmative. I know some clearly disagree and I would love an explanation as to how both of these issues would be addressed. Obviously these concerns address threshold issues and not the meat of the proposal, but I have a hard time getting past them. (These concerns arise especially in light of what seems an impending Maduro election victory).

Reuters released a piece of news today about how PDVSA is using derivatives (swap agreements) to get crude for its refinery in Curacao, since its own production of crude has been insufficient to supply its refinery capacity.

This made me think that a Chapter 15 alternative may not be that attractive if using derivatives to get oil really becomes the practice for PDVSA. This is because §1519(f) of Chapter 15 prevents the US court to operate the stay when such stay would not be available under 362(b) of the Code and such section exempts derivatives contracts from the stay. Can this be relevant for the overall analysis?

Accepting the author's assumptions of a Venezuelan government committed to reform and friendly U.S. policy, there is high but not insurmountable legal risk to Ch. 15 eligibility, recognition, and a confirmed plan. With a reform-friendly government, institutional creditors might finance a viable bankruptcy regime meant to endure. Reform friendly judges might populate the courts. A Venezuelan cramdown may even be coupled with negative press of holdouts to make confirmation of a plan a possibility. But holdouts will litigate at every step, increasing the costs of an already expensive strategy being implemented while reforming a broken economy with borrowed money. With high legal risk and so many moving parts, one of these steps is likely to fail. Even if they win a short stay, holdouts will probably opt out of a realistic restructuring plan in favor of litigating to the end.

I think one of the biggest benefits to the Chapter 15 plan could theoretically be the stay. Upon filing for Chapter 15, Venezuela is likely to get a stay that will last at least a few months while the eligibility and recognition issues are determined. This by itself could be valuable to give Venezuela some breathing room so that it doesn't have to keep using limited assets to pay creditors or risk default. However, one concern that was raised, and which I do not know the answer to, is how valuable a stay would actually be to Venezuela as it seems to have very limited assets at risk to begin with.

I do not believe that Walker and Cooper's Chapter 15 plan is realistic as a solution here, because I think it is likely to fail at one of the Chapter 15 stages. Importantly though, I do think there is at least a chance that the Chapter 15 could work. The possibility of a Chapter 15 may be enough to bring potential holdout creditors to the table to negotiate a restructuring, which could make this plan worthwhile.

It's great that Venezuela isn't constrained by the Contracts Clause, as Puerto Rico was. However, I'm not so sure that this green-lights a wholesale adaptation of the strategy attempted in Venezuela (although it is a tempting proposition). Even if Venezuela succeeded in setting up a bankruptcy law as proposed, significant substantive and policy-oriented questions remain. The proposal noted (when discussing the viability of receiving sufficient assistance from the IMF) that any reprofiling that involves multiple classes of creditors will be "an extraordinarily ambitious undertaking," displaying skepticism that it could even be possible at all ("even if it could succeed"), yet then proceeded to set out a plan that that would only succeed if it sufficiently involved multiple creditor classes and coordinated many creditors with competing or conflicting interests. Indeed, in order to be viable to qualify for Chapter 15, the Venezuelan bankruptcy proceeding would have to be to be collective and take into account "the rights and obligations of all creditors." This could be a significant barrier to recognition. As a legal realist, I'm inclined to believe a bankruptcy judge would hesitate (within reason and some doctrinal bounds, of course) before ruling in a contrary manner to the State Department's wishes. With this concern in mind, it could be difficult for any Venezuelan proceeding to gain recognition if it would be politically inexpedient. Finally, I wonder about the status of Russian and Chinese creditors' claims, as neither country has adopted the the UN Model Law on Cross-Border Insolvency.

PDVSA is an instrumentality of Venezuela government. When PDVSA issued its bonds, the possibility of PDVSA filing for bankruptcy was inexistent. Venezuela does not contemplate in its local law a proceeding that permits State own companies to reorganize. Also, neither foreign government or its instrumentalities can file for Chapter 11 of the Bankruptcy law. Moreover, all of PDVSA bonds prohibit any payment amendment without the consent of each holder.

This proposal tries to bypass all of this obstacles to allow PDVSA to obtain a stay of litigation by creditors and the ability to restructure its debt. But, how would a judge see all of this tricky moves?
Would a judge permit PDVSA to obtain this advantages that were not available to this instrumentality under Chapter 11?

I don't believe this proposal is realistic. But even in the case that the proceeding is recognized under Chapter 15, it won't happen as long as Maduro is still in power. PDVSA not only obtains benefits, but it would submit itself to US jurisdiction. It would be a risky move that Maduro will never take.

I believe that a Chapter 15 plan is possible, but I do not believe the plan that Cooper & Walker propose is realistic. This is because VZ and PDVSA have some serious obstacles to overcome in order for it to work. As mentioned above, the analysis of the Cooper & Walker proposal hinges upon PDVSA being eligible for relief by not classifying as an instrumentality of VZ, and VZ creating a bankruptcy law that gets recognized.

Whether PDVSA gets classified as an "instrumentality" of VZ is not a straight forward answer. Chapter 15 does not explicitly restrict an instrumentality, but Chapter 11 does. The question then becomes why would Chapter 15 allow something that Chapter 11 explicitly prohibits? The proposal does not squarely address this issue. Yet, this uncertainty may be beneficial. If US courts find PDVSA to be an instrumentality and restrict relief, then there is some "relief" in obtaining a stay from creditors from the day of filing until the courts decision on eligibility, which would be a couple of months. The question here is how beneficial is a stay to PDVSA?

Moving next to recognition. Given the current regime, it is highly unlikely VZ will attempt to make a bankruptcy law and subject itself to US jurisdiction. Moreover, the proposal assumes that there will be a new regime change that is creditor and US friendly. That is a strong assumption, even if there is a new regime change (which is no guarantee). With this new regime change, the proposal makes it seem that the exit consents (because of incentives) will easily persuade holdout creditors to jump on board. However, the proposal does not make it clear what these incentives are or will be.

Overall, I do not think the plan that Cooper & Walker propose is realistic given the present obstacles. Yet, I do believe that Chapter 15 is still a viable option, but more issues need to be addressed.

Look, it´s really simple.
There is not going to be a PDVSA.
PDVSA is gone, its plants and equipment and capacity to produce oil (let alone its bank accounts) are going to go to zero. Zero. Nothing to recover, ok? Chavismo is going to turn Venezuela into a non-oil-producing country. The liquidation value of a Venezuelan oil company is going to be a very round number.
The oil fields do not belong to PDVSA.
They belong to Venezuela.
And Venezuela is the new Cuba, and will be for a long long time. Communism and Chapter 15 or 11 or 111 may not mix too well.

Stays and binding creditors won´t do much if the debtor is gone from the face of the earth.
PDVSA´s production levels collapsed by more than 30% between end-2016 and end-2017.
Venezuelan observers predict a total collapse this year, as plants are not maintained, suppliers are not paid, employees walk out, and thieves steal what they can.
Venezuela needs to import fuels in order to produce its oil, but Venezuela is out of dollars.
If PDVSA can´t produce oil, PDVSA can´t repay its debts no matter how restructured or stayed.
So the real analysis should be: how do you collect from an entity that has disappeared from the living world?

The essential nature of Chavismo is looting.
Venezuela has been and is run by a looting regime.
The goal is to leave nothing un-looted so as to feed the massive personal fortunes accumulated by those in charge and so as to make sure no one can fend for themselves and thus survive outside of state handouts.
The entire non-oil productive sector has been looted and destroyed already.
And now they are going for the kill against the oil sector.
How do you collect from a regime whose goal is to erase any productive capacity (any capacity to gain sigificant revenue) from the land?
Of course, communism and socialism did destroy wealth massively before and in many other places (among other things because there is an ideological mandate in hard left politics to do just that), but what has happened and is about to happen in Venezuela is probably going to be totally unprecedented in terms of scorched earth-ness.
So the truly interesting paper would be one titled "Debt Collection in a Mad Max-Armaggedon-Holodomor Universe". Any takers?

I don’t know if I can be a taker on writing the “Armageddon” paper mentioned above, but I do have a few reflections on M&M’s post. There are pros and cons to the Ch. 15 approach. Two compelling features of it are that, as Cooper and Walker observe, a similar rubric almost worked in the context of Puerto Rico’s Recovery Act—which was foiled by preemptions not applicable to VZ—and, additionally, Ch. 15 case law is ambiguous enough for lawyers to work with (e.g. regarding PDVSA’s instrumentality status, eligibility, and whether the VPSRL would constitute a “foreign proceeding”). That said, there seem to be far greater drawbacks, which should caution against following the Ch. 15 method. For example, regarding the public policy considerations from § 1506, it seems fantastic to believe that a VZ proceeding would be granted Ch. 15 recognition in light of the US’s fraught relationship with VZ, alongside a number of other factors—e.g. US creditor interests, VZ’s Chavismo disposition toward and historic antipathy for the US, the US’s requited antipathy for VZ which has recently found expression through sanctions, etc. Walker/Cooper gave this public policy objection a nod (20-21), but it seemed to be disposed of in too conclusory/sweeping of a fashion. Finally, the costlier, litigation-inviting, circuitous route of the Ch. 15 option would not grant enough relief for it to be worth the trouble it would take. For a country drowning in debt, a stay would provide a negligible oxygen tank when VZ desperately needs a strategy that would pave a way for it to come up for air and actually breathe. In a word, the proposal assumes too much and requires very rosy outcomes, at every step of the way, for too many moving pieces; it thus doesn’t seem to be feasible, or at least preferable.

The common refrain seems to be that the chapter 15 and bankruptcy options, while potentially viable, have their biggest upside in securing a stay, for either or short, or potentially medium-length of time, on creditors going after PDVSA assets. However, I am not sure that there is really much value in securing that stay at all, even if they could get it for a significant period of time.

As the Cooper Walker paper observes, PDVSA has U.S. based assets in their CITGO/Holding company structures incorporated in Delaware, which regardless of any chapter 15 attempts, are vulnerable to attachment. The paper suggests a Chapter 11 route for those companies, but seems relatively pessimistic about the potential viability. Given that these are the key assets impatient creditors are likely to attack, already there are vulnerabilities this type of wide-sweeping reform will not touch.

In addition, it isn't clear to me what assets a stay would protect outside of the CITGO assets, as PDVSA has so little in the way of actual assets as far as I can tell. Most of their oil production equipment is leased or otherwise not claimable, the oil fields themselves are not PDVSA property, and their oil receivables have all but dried up at this point anyway, and would not be overly hard to protect through other actions not involving a chapter 15.

While I think legislative reform in Venezuela will ultimately be key to any move forward for the country, given the structure of PDVSA and the political realities of the situation, both in terms of party polarization and the increasingly short timeline, I don't think passing an overarching bankruptcy reform, or testing courts with a legally tenuous strategy of changing the governing laws, are good resources to explore.

While Chapter 15 proceedings may have the ultimate effect of bringing holdout creditors to the table, making restructuring more likely, if sanctions are a clear obstacle to restructuring, achieving eligibility and recognition would ultimately be fruitless for more than a delaying tactic.

The President's executive order, placing sanctions on RoV create an exception, authorizing all transactions "related to, the provision of financing for, and other dealings in bonds that were issued both (i) prior to the effective date of Executive Order of August 24, 2017, and (ii) by U.S. person entities owned or
controlled, directly or indirectly, by the Government of Venezuela, are authorized." Is it possible that this exception could be used to restructure already existing debt? If Chapter 15 is a path that is actually pursued, this is likely a question that will be litigated at length.

As a Venezuelan who understands what is truly going on here, Harvard´s Ricardo Haussman is asking for foreign military intervention to rid the country of the Chavista evil.
This may well be the only chance for bondholders to recover anything, before the entire country is erased from the land by the regime´s destructive far left policies.
So interestingly enough a return to a gunboat diplomacy of sorts would, once more and decades later, be a creditor´s best (and only) friend.

The Walker/Cooper plan does have appeal because of the specialized skills of bankruptcy court in handling multiple creditors at once. However, as others have mentioned, the United States would likely not acknowledge a bankruptcy proceeding under the Maduro regime, and further, there is always the risk that the next regime will not be as democratic as the U.S. government would like.
Although § 1506 has permissive rather than mandatory language, the State Department’s input will impact the decisions of US courts. And as Secretary of State Rex Tillerson emphasized on his recent five-country trip: “Venezuela and Cuba remind us that for our hemisphere to grow and thrive, we must prioritize and promote democratic values.”- Indicating that he will not ease the hardline stance against the Maduro regime.
Lastly, is the question of whether the use of Exit Consents to change the governing law of the bonds from New York law to English law is comparable to coercion, or whether when the parties negotiated the terms, they would have consented to the action. See Katz v. Oak Industries. In Katz, the Board of Directors concluded that their decision was “the last good chance to regain vitality for the enterprise.” However, I’m not sure if the bondholders care so much about Venezuela settling all of its debts as they do about Venezuela settling their individual debts. They may, as Professors Gulati and Weidemaier suggest view it as impairing their right to receive payment and sue to enforce that right.

My issue with the bankruptcy route is that it just seems like a lot of money and time for the maybe-possibility that they maybe-might get a stay for a little bit of time on Citgo. But this is money and time that Venezuela does not have. First, Venezuela would need to ensure that their legal proceedings overseeing the bankruptcy in Venezuela occurs. Then they would need to pray that the U.S. Bankruptcy Court is willing to acknowledging the proceeding - which is where I am extremely wary this will occur. Although the US doesn't use the public policy exception often for their rationale for not recognizing foreign proceedings, considering US's view towards Venezuela (i.e. political discourse and sanctions), and the US's generally paternalistic attitude towards South America to push democracy on those countries, I feel like this may be the time the Court invokes this doctrine. But even if the proceeding is recognized, and it the bankruptcy threat is able to bring creditors "to the table," Venezuela will have to have some plan to restructure the debt. And that's the more complicated part - how to restructure this enormous debt. So I think that instead of wasting all of the time and money for the small possibility to stay assets for a little bit of time and bring creditors to the table to discuss the debt, Venezuela should focus their time, money and energy on creating a tempting deal to get most of the creditors at the table (with exit consents of course), and then secure the Citgo and oil receivable assets such that the holdouters have nothing to grab.

Eligibility and Recognition…two words, a universe of gray area. But in this case, there are numerous other factors playing parts in what seems to me a very unlikely path to the U.S. bankruptcy courts. There was much talk about the broader language of Chapter 15, but only passing mention made to the court case that more closely connected the Chapter 11 and 15 eligibility. Any connection between the threshold for Sections 11 and 15 would more or less preempt any chances that PDVSA has for recognition.

What about Maduro’s government, their actions, and the Venezuelan constitution makes them think that they would be willing to make a move like this, especially one that would receive recognition in the US? As stated ad nauseum, PDVSA is responsible for 95%+ percent of the money flowing in to Venezuela, it has near-deity status socially, why would the people’s government (and someone as pragmatic…cough cough…as Maduro) put their crown jewel in the hands of a foreign judicial system? Especially a system in a country that they have such rosy relations with…There has to be value for them—or anyone for that matter—to make a decision like that, and it seems like they would perceive their costs much greater than the value received from a stay and potential restructuring assistance if they were in fact recognized. Declaring PDVSA bankrupt would seem to be worse in their perception than declaring the end of the Republic. It seems easy to say from the outside (especially in the US), that the benefits are greater, but we are not looking at this through their eyes.

What about Citgo, Citgo Holdings, and PDV Holdings? Would a creditor or PDVSA be able to attach them as debtor assets for the purposes of discharging the lien against the shares to secure the 2020 bonds?

Furthermore, we are still waiting on the result in the Crystallex cases to see if they succeed in attaching the US assets, as well as if they are able to win on the alter ego litigation connecting PDVSA to Venezuela. If they are in fact successful, it will be interesting to see which prong of the analysis the court uses based on the expropriation suffered by Crystallex which may allow a court to limit their decision to the Crystallex situation rather than having a broad effect throughout the Venezuelan/PDVSA creditor landscape (which may or may not be some sort of hybrid Mad Max/Highlander-esque terrain mentioned above). So are they an instrumentality? Which assets can be connected? Do they have value?

The final road block—as mentioned above—is regardless of the success in structuring an acceptable bankruptcy regime, do we really think that the English or American courts would allow PDVSA to use exit consents to effectuate the very thing that they said they would not upon selling these securities?

I believe it was Al Borland from Home Improvement who said it best, “I don’t think so Tim.”

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